The Fed and the Markets

The Fed rate hike of 75 basis points is through, and it is well on the lines expected by majority of the market participants. This takes the Fed Funds target range to 1.50% to 1.75%. It was on the back of a fiercely raging inflation at 8.60% in May that the Fed rate hike has come through. Fed has indicated that its target for inflation remains at 2.00% and that the measures intended to bring down inflation to its target levels will be undertaken as required. In the early days of build-up of inflationary pressures, the inflation target was revised to an average of 2.50% and this target now seems to have become superfluous.
The Fed presents an encouraging and positive picture of the economy except for inflation. The Fed statement reads like this, “overall economic activity appears to have picked up after edging down in the first quarter. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” The Russian invasion of Ukraine and the Covid-related lockdowns have been cited as two prominent factors leading to supply disruptions and higher prices.
The aggressive rate action by Fed is a reference point for other central banks to pursue the price stability objective more vigorously. It is also important from the currency perspective as the US Dollar has strengthened in the last few of months. Rate action is imperative to contain any further slide in the local currencies. The focus from hereon will be on the likely quantum of future rate hikes by the Fed. This need not
necessarily be in strict proportion to the inflation numbers but on the intensity of the threat perception drawn from future expected price level. However, this may remain uncertain with food and fuel prices at decadal highs and any drastic moderation looks less likely. There are no emphatic statements on the inflation trajectory from the Fed which deepens the uncertainties surrounding it.

The market would continue to speculate on the quantum of the rate hike in future FOMC meetings, and this will be the crux of the matter till inflation slows down and rate action too gets gradually truncated. The pressure on money market yields and long duration fixed income instruments will rise with rising policy rates.The persistent inflation, a large borrowing program and the winds of policy changes across the world etc. are likely to influence markets.

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